Question

In a different part of the world there a two different firms: Firm A and Firm B. These firms are each emitting 100 tons of pollution. Firm A faces marginal abatement cost MACA = 5A and Firm B faces marginal abatement cost MACB = 2A where A is tons of pollution abatement. The government’s control authority wishes the firms to reduce total emissions to 130 tons using the Cap and Trade system and plans to initially give each firm half of the permits

2b. How many permits will Firm A buy or sell?

2c. What will the market price of the permits be?

2d If instead of giving the permits away initially, the government decides to auction the 130 permits off, how much revenue will it generate?

Answer 1

2b) since total permit issued are 130,

& Each gets 130/2 = 65 permits.

Now as firm A is a higher abatement cost from so from A will buy permits and firm B will sell the permits.

Now at eqm, MAC should be Equalized across all firms.

So MAC_A = MAC_B & e1+e2 = 70.

e1,e2 are pollution units abated by each firm.

As 130 permits are issued, & total emission are 200, so total abatement needed = 70 units.

So 5e1=2e2, & e1+e2 = 70

Solving , e1*=20, & e2*=50

So firm A will buy 15 permits, since firm B will sell 15 permits.

2c) eqm permit price = MAC* = 5*20 = $100.

2d) now as eqm permit price = 100.

so total revenue generated = 100*130 = 13,000